Financial crises

Is the slow recovery unusual?

IN 2009, Carmen Reinhart and Kenneth Rogoff published This Time is Different, an empirical study of financial crises going back to the Middle Ages. Widely lauded by economists of all stripes, the book shows that recoveries following financial crises take a long time. Barack Obama, the U.S. president, has taken this message on the road to explain why he ought to be reelected despite a lacklustre economic record. Unsurprisingly, economists sympathetic to Mitt Romney, Mr Obama’s Republican challenger, have produced studies claiming that the slow recovery is not due to the legacy of the financial crisis but rather the incumbent’s allegedly growth-stifling policies. Fortunately, Ms Reinhart and Mr Rogoff have published a new paper (no link, sorry) that clarifies the issues from an apolitical perspective. Their central finding is that their critics have misinterpreted the data.

The mistaken view comes largely from the 2009 book ‘This Time Is Different,’ by economists Carmen Reinhart and Kenneth Rogoff, and other studies based on the experience of several countries in recent decades. The problem with these studies is that they lump together countries with diverse institutions, financial structures and economic policies…In a recent working paper for the National Bureau of Economic Research, Joseph Haubrich of the Federal Reserve Bank of Cleveland and I examined U.S. business cycles from 1880 to the present…We found that recessions that were tied to financial crises and were 1% deeper than average have historically led to growth that is 1.5% stronger than average. This pattern holds even when we account for various measures of financial stress, such as the quality spread between safe U.S. Treasury bonds and BAA corporate bonds and bank loans.

In their response, Ms Reinhart and Mr Rogoff are quick to point out that Messrs Bordo and Haubrich use a very strange definition of the word “recovery”:

The recent op-eds focus on GDP growth immediately following the trough (usually 4 quarters). For a normal recession, the restoration of positive growth is typically a signal event. In a v-shaped recovery, the old peak level of GDP is quickly reached, and the economy returns to trend within a year or two. In Reinhart and Rogoff (2009), we examine both levels and rates of change of per capita GDP; recovery is defined by the time it takes for per capita GDP to “recover” or return to its pre-crisis peak level. Taylor’s chart shows the recovery from the Great Depression as the strongest in the history of the United States, even though (as we show in our book) it took about a decade for the US to reach the same level of per capita income as its starting point in 1929. For post-WWII systemic crises it took about 4½ years to regain lost ground; in 14 Great Depression episodes around the world (including the US) it took 10 years on average. A focus on levels is a more robust way to capture the trajectory of an economy where the recovery is more U or nearly L-shaped than V-shaped. It also avoids exaggerating the strength of the recovery when after a deep recession there is a large cumulative decline in the level GDP. An 8 percent decline followed by a subsequent 8 percent increase does not bring the economy back to its starting point.

As any investor can tell you, a loss of 20% is not offset by a gain of 20%—you are still down by 4% (0.8 times 1.2 equals 0.96). To his credit, Mr Bordo admits this salient fact:

Since contractions related to financial crises are generally deeper and longer than other recessions, they are followed by recoveries that take longer than normal to see output return: Since 1887, the growth of real GDP over both the recession and the recovery was 1.2% in recessions with financial crises and 2.2% in those without.

This alone settles the entire argument in favor Ms Reinhart and Mr Rogoff. Financial crises are very bad for growth over long periods. But there is more. Messrs Bordo and Baudrich also have a strange methodology for determining which recessions were caused by financial crises. The most obvious flaw is the fact that their study starts in 1880, thereby excluding the Long Depression of the 1870s. Ms Reinhart and Mr Rogoff point to other problems:

Part of the confusion in the recent “US is different” op-eds is a failure to distinguish systemic financial crises from more minor ones and from regular business cycles. A systemic financial crisis affects a large share of a country’s financial system. They are quite distinct from less severe events that clearly fall short of a full-blown systemic meltdown, and are referred to in the literature as “borderline” crises. The distinction between a systemic and a borderline event is well established according to widely accepted criteria and is clear in both our work and that of other scholars. Indeed, in our initial paper on this topic (Reinhart and Rogoff, 2008), we showed that systemic financial crises across advanced economies had far more serious economic consequences than borderline crises. Our paper, written nine months before the collapse of Lehman in September 2008 showed that by 2007, United States already shared many of the key recurring precursors of a systemic financial crisis: a real estate bubble, high levels of debt, chronically large current account deficits, and signs of slowing economic activity. Today, there can be little doubt that the United States has experienced a systemic crisis. This is, in fact, the first systemic financial crisis the United States has experienced since the Great Depression. Before that, notable systemic post-Civil War US financial crises include those dated in 1873, 1893 and 1907.

Comparing the recent performance of the economy against those four episodes, we appear to be doing rather well:

Of course, this relative outperformance does little to change the sad fact that this recovery has been exceptionally anemic compared to more recent experiences:

The Great Depression is the only useful analogy to what has happened this time. We learned and did enough to prevent a complete financial collapse. We cannot act on what we learned about recovery, because the GOP has blocked it in the attempt to damage Obama and the Democrats.

History will hold them in the contempt they deserve for intentionally harming their country for partisan political gain.

"This Time Is Different" was the best of all the books on the financial crisis, and its likely aftermath.

But it was more than finance and more than a crisis. Like the movie Inside Job, it failed to emphasize the broader social and economic trend that created the financial imbalances.

For 30 years, an ever rising share of American workers have earned less, and yet chosen/been induced to spend more, to maintain their expected standard of living/live large. (The difference depends on your politics). In Europe the same situation occurred, but instead of spending more Europeans worked less.

Business prospered and the rich piled up lots of paper wealth because the difference between worker earnings and consumer spending was papered over by debt, first private in the U.S. and then public. This house of cards has now collapsed. The financial sector merely found a way to accommodate and amplify the broader irresponsibility of a generation or two, paying itself richly for doing so.

An economic epoch is over. And leadership of institutions, public and private, is concentrated in the hands of those who prospered in that epoch. They have no idea what has happened, or what to do.

Have you studied how long it takes to come out of crises where concurrent major health care overhaul, financial industry regulation and promise of higher taxes face employers in an industrialized world where there are as many lower tax and regulatory regimes abroad as exist today?

Anyone waiting for a jobs recovery with President Obama or Governor Romney is waiting for a huge disappointment.

But in the malaise of decline, traditional businesses will falter while niche businesses involving basic necessities will have opportunities.

Case in point: Because of the financial crisis in real estate, real estate development came to a halt. Yet, people need shelter. One of the students of the Certification Real Estate Development Course (seeing homes could not be purchased) is able to put together a $36,000,000 Apartment Complex in San Diego ready for Joint Venture Investors.

The same niche business opportunities exist in other fields where talent left the industry.

The gift of survival is key now since the U.S. Economy bottomed, hit bottom, and it's staying there.

And the U.S. Government and FED Bernanke money printing monetary policy has not worked, will not work and is coming to an end. (It's just a continual, temporary band aid)

And so, if you possess an entrepreneurial spirit, now is the time to find that niche business and get started. Nobody is going to help you. You will need to be highly motivated. But if you wait, thinking jobs are coming back, you're waiting to die financially.

And don't be fooled by the Presidential candidates. There is NO economic solution for Average Americans.

The wealthy can prosper in this type of economy because of low asset prices, FED Bernanke manipulated stock market, but Average Americans will need to become entrepreneurs.

What if the administration ,(whoever it is )declared that the first $80,000.00 earned is tax free as it is in Trinidad.Do you think that would be enough of an entrepreneurial incentive to stimulate the economy.

Unemployed people cost money.

Let an entrepreneur keep enough of his earnings to sustain a family and he himself will reinvest it in and with other like minded entrepreneurs. Do this and I will guarentee a sustainable economic boom that hasn't been seen in half a century.

Excellent citation there from Baudrillard. Why would you say that capitalist civilization is so afraid of watching the lights go out, even when they are not performing any productive function? Is that like a silent re-enactment of Capital's own idiosyncratic ontology, namely, that it never sleeps?

1. Reagan BEGAN deregulating finance, particularly with regards to interest rates and what banks can do with customers' deposits. While dynamic interest rates and flexibility CAN be beneficial, in THIS CASE it created a bubble.

2. The problem with the New Deal regulations was not the regulations themselves (which, along with Social Security, is one of the BEST things we got out of the Great Depression). The problem was that the regulations were not UPDATED to include DERIVATIVES, which was one of the CENTRAL causes of the savings and loans crisis. Derivatives were already ~$14 trillion market in the 1990s. Today, it is HUNDREDS of trillions of dollars. In short, derivatives ALONE can cause a SEVERE financial meltdown.

3. Bipartisan policies for easy credit were designed to reduce CONSUMPTION inequality in the face of skyrocketing INCOME inequality. This phenomenon was partly caused by globalization and a stagnant education, but MOSTLY caused by 3 factors: the decline of private unions because reforms were not UPDATED; the runaway increase of wealth from "job creators," aka hedge fund managers and executives whose compensation had LITTLE link to LONG-term profitibility; and the aggressive slashing of tax rates, slanted towards the rich and the uber-rich. The U.S. could have conceivably developed protections seen in the EU and become more like a Norwegian country (which, for the record, balances efficiency with LOW income inequality and MUCH HIGHER social mobility); instead, because businesses have a near-MONOPOLY on campaign funds, they chose easy credit.

Basel accords and market "self-regulation" have two major shortcomings. First, there is LITTLE OFFICIAL OVERSIGHT, meaning that banks can do whatever the fuck they want. Second, it ignores that derivatives can create dangerous levels of leverage DESPITE high capital reserves.

My letter is about the next stage of the current crisis. Now about my forecast accuracy - as I chose a job in Scotland in 2005, I have been thinking about this crisis; I knew, that it is unexpected and that it lasts until 2020. Nouriel Roubini predicted the twelve stages of current crisis, I predicted the first eight stages - how it will start and develop in USA and UK, but I didn't predict that it covers the whole world and in 2005 I knew that 2020 China will be the largest economy in the world.

Global debt and derivatives market is like a gigantic house of cards, if you take a one card or a one big bank out, you are having crash, as show 2008 crisis, now this gigantic financial house of cards is very fast growing - FINANCIAL IMPLOSION: Global Derivatives Market at $1,200 Trillion Dollars … 20 Times the World Economy

USA, UK, EU and Japan are trying to fix a this gigantic financial bubble or a house of cards by printing the money: trillions dollars, pounds, euro, yen, it is visible part of this crisis and there is invisible part - the tax havens, where is 21-32 trillions $ - main reason for this crisis and the biggest danger now.

A dollar crash is inevitable, as now is going the four processes, which can not be stopped:
1. The ever worsening economic situation in the world, because has been not eliminated a main reason for this crisis - the financial black holes - tax havens: sixty years ago, USA companies accounted for 32.1% of the federal tax take, but by 2009 that proportion plummeted to 8.9%, over the same period, the burden on ordinary workers (paying standard payroll tax) soared from 10% to 40% of all federal tax receipts, according to official data, the same processes took place in all developed countries and the tax havens sucked from world economy 21-32 trillions $.
2. The decreasing dollar market share.
3. The protectionism, the regulation of investment, prohibition to sell the most important companies and more and all these measures have been taken to guard against the dollar...
4. The global system of the tax havens is becoming every year bigger and stronger and more influential, it is practically impossible to reform it now, as show the tax havens history.
A only way to reform the global financial system and central part of it - the tax havens, is crash, a only one question is when?

But . . . but . . . if you accept that what we have is a financial crisis, not unlike various ones before, then . . . you can't blame all the current economic issues on the current administration. And since that is unacceptable, this time must be different somehow -- so the recovery could have been far faster, if only....

It's just a matter of deciding what is different, so we can put the blame where we want it to be. (Although if we get into office, and aren't able to do any better, we reserve the right to embrace the whole Reinhart and Rogoff approach to explain why it isn't our fault that things didn't instantly get better when we came into office. After all, nobody will remember what we said about it before we came into office.)

Thanks for the effort, but that isn't the paper I'm thinking of. In the paper you link to she only goes back to 1885. The one I have in mind spends a great deal of time on the 1870's because it was considered a long depression. She shows the problems in methodology and corrects them, making the depression of that period a normal one.

yes I'm told that even though their predictions never came true regarding the slapping on of piles of debt, that had we not burdened future generations w/ trillions of dollars armageddon would have taken hold and the cats would eat the dogs and revelations would come to pass and I'd be forced to live w/o indoor plumbing.

I agree with you though, what we don't want is a double dip. we should, in the interests of never having another recession, simply run 3 trillion in deficit next year, and 5 trillion in deficit the year after that, and so on and so forth. because to do anything but that is INSANE, and will lead to the imaginary armageddon we're told we avoided by doing everything they wanted even though nothing they said would happen actually happened.